Eric Nee: The China Syndrome

By Eric Nee |
Posted 03-01-2004

China's meteoric rise from a closed, near- feudal society to the most dynamic economy on the globe has been mostly good news for U.S. CIOs and captains of technology. An enormous supply of cheap labor, coupled with modern factories, means that prices for most high-tech gear should remain low for years to come. Armies of highly educated yet low-paid scientists, engineers, accountants and other professionals provide a long-term opportunity for U.S. firms to get skilled work done for less. Add to that the millions of newly minted middle-class Chinese and thousands of growing businesses ready to buy, buy, buy, and what's not to like?

Well, there is another side to China's emergence as an economic power, and one that poses a threat to the U.S.: China's use of its growing economic might to try to dictate critical technology standards. China's current effort to establish its own 3G wireless standard has little chance of success outside some parts of China, and is mostly an annoyance. But in the years to come, China may be able to use its heft to dictate standards in newly emerging markets, and to use them to its own advantage. The implications of this could be profound, because whoever sets technology standards will also control the direction the industry takeswho wins, who loses, and where the wealth created by that technology ends up.

For the past 50 years, the U.S. has held sway over most technology standards, and over the technology industry itself. Not only were U.S. companies such as IBM Corp. and Intel Corp. the most innovative creators and biggest producers of technology, but U.S. consumers and businesses were the largest buyers as well. That symbiotic relationship helped make the U.S. the most powerful country in the world, and helped U.S. companies become the most creative and productive users of information technology.

To be sure, China's $1.2 trillion economy still ranks a distant sixth behind the world-leading, $10.2 trillion U.S. economy. And IT spending in China is expected to total $30 billion in 2004, just 3.3 percent of the world market. But the gaps are closing fast. China's supercharged economy grew an average of 10 percent a year through the 1990s, eclipsing the U.S. growth rate of 3.4 percent annually during the period. And Chinese IT spending is expected to jump almost 20 percent in 2004, nearly four times the rate of growth for the rest of the world.

Already China is emerging as one of the world's largest single markets for some digital products. China recently passed Japan to become the second largest PC market in the world, trailing only the U.S. In 2003, 13.3 million PCs were sold in China (8.6 percent of the world market), compared with 52.7 million in the U.S., according to IDC. And China is already the largest mobile-phone market in the world, with 270 million users at the end of 2003. This year, China expects to add another 52 million wireless customers, according to the Chinese Ministry of Information Industry. That will make the Chinese mobile-phone market larger than the entire population of the U.S.

China is also emerging as a force to be reckoned with when it comes to manufacturing digital products. China is the leading manufacturer of laptops, making about half the world's supply, according to IMS Research. It is also the leading manufacturer of mobile phones, making about 35 percent of the world's supply, according to China's National Development and Reform Commission. But most of the laptop factories are run by Taiwanese companies, not Chinese firms. And most of the mobile phones are made for foreign firms like Nokia Corp., not for Chinese companies.

There's the rub. China makes and buys more mobile phones than any other country, but much of the wealth that is created goes to the foreign companies that create the technology, set the standards and control the industryfirms such as Qualcomm Inc., Motorola Inc. and Nokia. But the Chinese government has set out to change that. One of the primary ways to elevate Chinese firms from mere assemblers into innovative firms that can compete worldwide is for the government to use China's market heft to create competing standards, and hand those standards off to Chinese firms.

Rather than adopting CDMA2000 or WCDMA, as has the rest of the world, the Chinese government, together with Chinese firms, has developed a third 3G standard, dubbed TD-SCDMA. The challenge for China is that the mobile-phone market is getting mature, with tens of millions of people outside of China already using the existing standards. So while CDMA2000 and WCDMA are already well established in the rest of the worldand even in China itselfTD-SCDMA is still undergoing tests.

Nevertheless, the TD-SCDMA effort has achieved one of China's goals: to solidify the position of Chinese firms in the telecom-equipment industry. Because China is such a huge market, and because TD-SCDMA is virtually guaranteed some portion of it, foreign behemoths such as Nortel Networks Ltd., Royal Philips Electronics N.V. and Siemens AG have partnered with smaller Chinese firms, such as Datang Mobile and Huawei Technologies Co. Ltd., to manufacture TD-SCDMA equipment.

China is playing catch-up in the 3G market, but it stands a better chance of wielding influence in emerging wireless markets where standards are still embryonic. That's why the Chinese government devised a new encryption standard for Wi-Fi, dubbed WAPI, that is different from the IEEE 802.11 standard certified by the global Wi-Fi Alliance, and adopted by the rest of the world. China then provided its encryption technology free to 11 Chinese firms. By June 1, any company selling Wi-Fi gear in China will have to license the technology from one of these 11 firms and incorporate it into their equipment. The Chinese firms range from those already on the cusp of becoming world-class competitors, such as Legend Group Ltd. and Huawei, to much smaller firms trying to gain a foothold.

Because China is rapidly becoming one of the largest wireless markets in the world, most foreign firms will probably support China's encryption standard as well as the IEEE standarddispute increasing pressure by the U.S. to relax the requirement. Broadcom Corp., for example, plans to support WAPI but won't have a chip ready by June 1. "Broadcom intends to comply with the law," says Jeff Thermond, vice president and general manager of Broadcom's home- and wireless-networking business unit.

Of course, China's efforts could backfire. Instead of boosting Chinese firms, the new standards could isolate them, and the Chinese market, from the rest of the world. But as long as China concentrates on markets where it has a sizeable presence, such as wireless, that is not likely to happen.

Regardless of the outcome for China's technology companies, the impact on CIOs is real. Companies with offices or manufacturing plants in China will have to support multiple standards, one for China and one for the rest of the world. Users who travel between China and the rest of the world will be faced with the same challenge of buying devices that support multiple standards. And vendors will be forced to divert scarce resources away from innovation.

Just when it looked like the world was moving away from multiple proprietary standards to fewer industry standards, we now seem to be heading in the opposite direction, thanks to the Chinese. That is bad for IT companies, and bad for users.

Eric Nee, a longtime observer of Silicon Valley, has served in a variety of editorial positions at Forbes, Fortune and Upside magazines. His next column will appear in May.